6 Reasons To Consider Buying Longevity Insurance
Over the last few years, annuities have begun to take a more prominent role in the retirement income planning process and part of the reason is longevity risk. According to retirement expert Tom Hegna, CLU®, ChFC®, CASL®, author of Pay Checks and Play Checks, “math and science demands that in order to have a successful retirement, you must take longevity risk off the table. Stocks, bonds, CDs, and Real Estate CANNOT take longevity risk off the table. Only some form of lifetime income annuity can do it – Social Security, Pension, or lifetime income annuity.” In 2014, annuity sales for the U.S. reached nearly $230 billion, representing a 3.8 percent increase over 2013 and a nearly 8 percent increase over 2012 sales. Product innovations and enhanced company offerings have continued to come to market allowing for a wider range of benefits for consumers as different types of annuities are suitable for certain situations and not for others. One particular type of annuity, often referred to as a deferred income annuity, or longevity insurance, is one product that has seen the fastest growth (from $211 million in 2011 to about $2.7 billion in 2014).
The deferred income annuity is a relatively simple product. It promises a specified monthly income amount beginning at a future date in exchange for a premium. Payouts can be made for a single life or over a joint lifetime (to protect income for a couple) and the promise can include death benefits and inflation protection. For example, a 65-year-old man willing to use $50,000 of retirement assets to buy a single life annuity beginning at age 85 will receive $2,109 a month beginning at 85, (using the average of the three best paying products available – pricing data from Cannex Financial Exchanges). This is over $25,000 a year, meaning that the payout rate is about 50 percent of the initial premium. A non-reducing joint annuity, assuming a same age female spouse, drops the payout to about $1,194 a month because of the longer assumed payout period. Add a return of premium death benefit to the joint annuity if death occurs before payouts begin and the monthly payment drops again to $981.
One barrier to use this product within a qualified plan (401(k)) or IRA was recently lifted by IRS regulations in November 2014. Without the guidance, purchasing a deferred income annuity with a start date after age 70½ could have violated the required minimum distribution rules. The new regulations allow for deferred income annuities with start dates as late as age 85 as long as certain other requirements are met (qualifying products are called qualified longevity annuity contracts (QLAC)). To qualify as a QLAC: 1) the total premiums paid on any given date in all IRAs owned by an individual cannot exceed the lesser of $125,000 or 25 percent, 2) the start date cannot be later than the first day of the month after the individual turns 85, 3) payouts can only be for a single or a joint life, and 4) the only allowable death benefit is a return of premium.
The new regulations are a meaningful change as many retirees have a significant portion of their retirement assets tied up in IRAs and qualified plans and now these funds can be used to purchase this product. Currently, there are only a few companies offering the QLAC in an IRA. However, it is expected that another half-dozen or so companies will roll out QLACs later in 2015. QLACs will not offer all the features and options available in other types of deferred income annuities, but they represent an important shift from the Government to recognize the importance of longevity insurance as part of a retirement income plan and bring increased attention to a viable planning technique. As such, this article will take a quick look at six reasons why someone would want to purchase longevity insurance as part of their retirement income plan.
1) Protect Against Longevity Risk:
Retirees are living longer than ever before, which also means their assets need to last longer than ever before. One of the biggest challenges in retirement planning is dealing with longevity risk, the risk of outliving one’s assets. Especially for those who only have Social Security as a guaranteed source of retirement income, building in more sources of lifetime income can help insure sufficient income at the end of life when going back to work to fix a shortfall is not an option. The annuity has an impact on how much can be withdrawn each year from the remaining IRA account, as the portfolio only has to last until the annuity income kicks in. This means that withdrawals can be somewhat larger as the time horizon for withdrawals is fixed.
2) Maintain More Flexibility:
The advantage of the longevity insurance annuity approach over simply buying an income annuity at retirement is that the portion of the portfolio needed to buy the income is much smaller. This means “locking in” with a smaller portion of the portfolio. Systematic withdrawals can be taken until annuity payments begin. This allows the flexibility to change spending as needs change and modify investments with market, tax law, or other changes. According to Mr. Hegna, “the real reason to buy an annuity or longevity insurance right now is to ‘lock in’ the highest longevity credits that we will likely ever see.” It also means committing fewer assets to longevity risk in case life is not as long as expected – allowing a larger legacy for heirs.
3) Prepare For Long-Term Care Costs:
Long-term care costs can be one of the biggest impediments to living a financially secure retirement as the expenses can quickly become overwhelming. For instance, a year in a semi-private nursing home room can easily cost more than $100,000. While family members provide the majority of long-term care services without financial compensation, there is often still a negative financial impact on the family due to lost time, additional care costs, and missed work opportunities. As such, even someone planning on having family members provide long-term care services could consider a longevity annuity to help fund some of the costs. While longevity insurance will not match up as perfectly with the actual long-term care costs incurred by an individual in the manner that long-term care insurance could, the deferred annuity can still provide an increased stream of income when someone is most likely going to need long-term care. Long-term care is much more prevalent with retirees aged 80 and older than it is for those aged 65. As such, starting a stream of income later in life can help pay for long-term care costs, as nearly 70 percent of people over age 65 will need some long-term care services.
4) Prepare for Frailty
The need for long-term care is just one aspect of the changing needs of aging retirees. Years before long-term care is needed there can be additional costs of maintaining a home such as lawn care, house cleaning, and other services need to be purchased. As mental capacity changes, financial decisions become more difficult as well. Having annuity income kicking in at a later age allows for simplifying financial affairs.
5) Replace Other Lost Income Sources:
Pre-purchasing income that starts later in life can meet other needs as well. According to Dave Littell, Director of the RICP® program at The American College, “an income source that kicks in later in retirement can replace part-time income from wages, lost benefits from Social Security after the death of a spouse, or loss of purchasing power due to inflation.” Some sources of income may not be entirely reliable as well. For example, unless the Social Security system is revised, it is only expected to be able to pay out about 77 percent of promised benefits after 2033. While there is a good chance this will not happen, someone concerned about this drop in income could use longevity insurance to address this contingency as well.
6) Peace Of Mind:
Besides all the other reasons to consider longevity insurance, research shows that retirees with more guaranteed income sources are happier. They are less concerned about their finances after they have secured guaranteed income sources, income they know they cannot outlive. As such, individuals with guaranteed income, such as longevity insurance, feel more confident about meeting their financial goals.
With longevity insurance finally available in an IRA and qualified retirement plans, where many people have most of their investable retirement assets, this tool should be considered when building a retirement income plan. This is a complex decision that has to be made in the context of a comprehensive retirement income plan and there are other annuity products which may be better suited for a specific situation. If longevity insurance is a possibility, there are still important decisions about how much income to buy, when to start the income, and the features of the annuity product. For these reasons, it is best to work with a qualified financial planner with retirement planning expertise when building a retirement income plan.
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